BALTIMORE (Stockpickr) -- You may not realize it, but investors hate the stock market right now. That may sound fishy, especially after a five-year rally in the big S&P 500 index, but the numbers tell a different story.
As I write, total short interest for the U.S. market is sitting at the highest levels we've seen since the big stock indices bottomed back at the start of 2009. That's a pretty extreme level, and it means that investors are making some big bets that stocks are headed lower. The good news is that hate can be a pretty powerful market indicator when it reaches extremes -- powerful because it's usually wrong.
That's not just my opinion; the data bear it out as well. Over the last decade, buying the most hated and heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28% each and every year.
When I say that investors "hate" a stock, I'm talking about its short interest. A stock with a high level of shorting indicates that there are a lot of people willing to bet on a decline in its share price -- and not many willing to buy. Too much hate can spur a short squeeze, a buying frenzy that's triggered by short sellers who need to cover their losing bets to exit the trade.
One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
Today, we'll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in the weeks and months ahead.
Up first is Express Scripts (ESRX), the largest pharmacy benefit manager in the country. The health care sector as a whole has been hot in recent months, and Express Scripts has been no exception. Since November, this $62 billion stock has seen shares rally by 10.5%, outperforming the S&P 500 by triple. That outperformance has been grating on short sellers, who have boosted their bets to a short interest ratio of 19.38.
At current trading volumes, it would take shorts almost a month of buying pressure to exit their bets against ESRX.
Express Scripts is basically the middleman for drug companies, pharmacies and patients administering more than 1.3 billion prescriptions last year. That utterly massive scale means that the firm has some big benefits. It's able to get better pricing on drugs as a result, earning a profit on the spread between what ESRX bills to the insurance company and what it pays suppliers. Those spreads are paper-thin (ESRX converted just 1.7% of sales into profits last year), but that's actually a good thing. Small profits mean that ESRX's partners and customers are less likely to cut it out of the picture. Instead, the firm makes its money on volume.
The demographic trends look good for pharmacy benefit managers such as Express Scripts in the years ahead. As an aging U.S. population increases demand for drugs in the long-term, ESRX should continue to have the wind at its back. More near-term, momentum is clearly on the side of longs right now -- and that gives ESRX short squeeze potential.
Last week's positive jobs numbers looked good for the economy overall, but they were particularly bullish for HR outsourcing firms such as Paychex (PAYX - Get Report). Shares of the $17.8 billion payroll solutions stock are up 6.5% year-to-date in 2015 -- and that could just be the beginning.
Paychex provides payroll and HR services to approximately 580,000 customers, most of them small and medium-sized businesses. The firm helps those smaller firms navigate the labyrinth of tax and compliance issues involved in paying employees, collecing profits in the process. To counter the job losses of the Great Recession, PAYX stepped up its offerings, working hard to cross-sell customers on add-ons such as 401(k) administration and worker's comp insurance. Now, as the job market rebounds, Paychex has been enjoying brisk revenue growth.
The possibility of higher interest rates that the Fed keeps hinting at could be a windfall for PAYX. That's because historically, Paychex has earned substantial income from float interest (the interest money it earns on massive payroll accounts between the time that employers deposit funds and employees cash their checks). But with rates held near zero for the past five years, that revenue stream has dried up. If higher rates do come later this year, it's free money for Paychex.
Still, investors hate this stock right now. With a short interest ratio of 10.67, it would take more than two weeks of buying for shorts to cover at current volume levels.
Graphics card maker Nvidia (NVDA - Get Report) hasn't been getting much love from investors of late. With a short interest ratio of 10.03, NVDA boasts one of the highest levels of shorting in the large-cap segment of the market. The argument is easy enough to understand. As computer companies increasingly turn to integrated graphics modules, PCs are less likely to ship with Nvidia-branded chips onboard. But being short Nvidia looks like a crowded trade right now.
Nvidia generated 82% of its revenues from conventional graphics processing units (GPUs) last year, but the firm has been shifting its focus to more "moaty" offerings more recently, such as its mobile Tegra graphics chips. Most recently, Nvidia has been investing heavily in supercomputing, servers and mobile graphics. Those niche graphics products enable the firm to leverage its existing expertise in an under saturated market.
As serious graphics chips make their way into more unconventional products -- such as cars, phones and home appliances -- Nvidia's addressable market has room to grow well beyond its core PC business. Likewise, expect those unconventional GPU implementations to work their way down to less expensive devices (like we've seen in phones over the last decade).
In the meantime, NVDA's huge $3.4 billion net cash position adds up to almost a third of the firm's current market capitalization. That's a big risk-reducer right now --unless you're a short seller.
$9 billion IT services vendor Computer Sciences (CSC) is another tech sector stock that short sellers hate in 2015. CSC sports a short interest ratio of 10.66 at last count. That's good enough to make it a short squeeze candidate this May.
CSC provides IT services ranging from personnel staffing and consulting to infrastructure projects for business and government clients. As enterprise IT budgets climb to keep up with record demand for data processing capacity, CSC is well-positioned to grab a meaningful chunk of that cash. Repeat business is a critical part of CSC's continuing success -- the majority of the firm's revenues come from prior clients who understand the value proposition that CSC's expertise provides.
To battle competition, CSC has focused on getting rid of non-core businesses that lack a moat, and it's worked to cut approximately $1.4 billion in annual costs through a major turnaround program. That means that CSC has been a firm in transition in the last couple of years -- and that's made it seem like low-hanging fruit for short sellers chasing mediocre performance levels.
That could be a big mistake. Look out for a potential short squeeze catalyst in CSC's May 19 earnings call.
Last up on our list of short squeeze candidates is SunEdison (SUNE). SunEdison is a solar energy company that builds and operates solar power plants as well as complete solar systems for homes, businesses and utility customers. The acquisition of 521 MW of wind and solar power generation capacity from First Wind makes SunEdison the largest renewable energy utility in the world.
The falling cost of solar power is the biggest tailwind for SunEdison. Since 2008, solar power costs per watt have dropped by 75% -- and that trajectory is on track to continue, as increased efficiency makes solar power economically viable in more places. As more homeowners and businesses look to lower their economic and environmental energy costs, SUNE's unique expertise gives it a major leg up when compared to rivals.
The fact that SUNE has the technical expertise and manufacturing capacity to serve the solar industry (SUNE's units manufacture silicon wafers, solar modules, and other major solar components) also give it an advantage that's difficult for new competitors to replicate. Right now, SUNE's short interest ratio sits at 11.1.